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Massive Inventory Cycle?

The competing narratives of a soft landing or a recession are dominating headlines. Bruce Kaser recently presented his subscribers with a compelling alternative: an inventory cycle.

Glowing Light Bulb Standing Out From the Crowd

Editor’s note: The prevailing debate in the market these days is largely about whether we face a recession or whether the Fed can engineer a “soft landing” and avoid a recession entirely.
Despite the Fed’s repeated interest rate hikes, the labor market’s residual strength presents a compelling counterpoint to recession arguments. But what if it’s not a binary choice at all? Cabot Undervalued Stocks Advisor Chief Analyst Bruce Kaser recently presented a third alternative to his subscribers: an inventory cycle.

The entry below is an excerpt from December’s issue of Cabot Undervalued Stocks Advisor and we’ve elected to share this with readers of the Daily because it presents a narrative fit to current economic conditions unmatched by anything we’ve encountered elsewhere.


Massive Inventory Cycle?

We’re not market or economic forecasters, but we do try to make sense of what is going on. And, as we’ve commented on in earlier notes, it seems more and more likely that what is going on in the economy is a huge inventory cycle. Things were mostly in balance prior to the pandemic … then we had a complete collapse in demand followed by a massive surge in demand in some industries (cars, houses and tech gear as notable examples) but not others (restaurants, travel and retailing). At the same time, we had a collapse in the supply of just about everything as factories closed and people stayed at home.

This shifted abruptly as the economy reopened and many supply-demand imbalances reversed. Supply chains got jammed up, Russia invaded Ukraine and the federal government dumped a few trillion dollars of free money into the economy. Industries across the economy were thrown out of balance, first in one direction, then the other. It is surprising that most companies navigated through all this as well as they did.

Picture a calm pond, then drop a boulder into it. Everything is jumbled, massive waves roll outward, and then the waves rebound off the shore and back to the impact site, waves crossing other waves. It’s chaos … but eventually it all calms down.

With supply coming back online, and demand waning, the shortages are turning into gluts. Retailers are stuck with massive unwanted inventory. Oil has dipped back below $75. Tech gear and semiconductors are in ample supply. Housing is slumping.

We think that, if our view is right, the economy should normalize by late 2023 or early 2024.

What makes this a challenge is that most professional investors have never seen a true inventory cycle. The last REAL inventory cycle was probably 40 years ago, if not longer. So, most investors think that we’re headed into a recession, perhaps one that is deep and dark.

A related mistake is that many investors use year-over-year comparisons, which can be misleading. For example, in October, existing housing sales fell 28.4% from a year ago – implying a collapse in housing demand. But, this comparison is against the very strong year-ago post-pandemic demand surge. When compared to the pre-pandemic average, October sales were down only about 16%. And this decline may mostly be under-demand that offsets over-demand during the pandemic period. Perhaps what we are seeing is a reversion toward normalcy.

So, we may see recessions that roll through some industries and then others, but not all industries at the same time. If we’re right, this is probably the time to jump on cheap but reasonably healthy cyclical companies like many of those on our recommended list.

You can enjoy regular insight like you’ve just read (as well as the recommended list) in every issue of Cabot Undervalued Stocks Advisor. Consider subscribing today!


Bruce Kaser has more than 25 years of value investing experience in managing institutional portfolios, mutual funds and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company.